Carbon Swings Hit Year High Amid Supply Concern

Feb. 1 (Bloomberg) -- European Union emission permit prices
are swinging in the widest range since January 2012, encouraging
speculation that may be exacerbating losses amid a supply glut.

Thirty-day historical volatility for December carbon
allowances rose to 78 percent yesterday on ICE Futures Europe in
London, the highest in a year, according to data compiled by
Bloomberg. The benchmark contract has fallen in 18 of the past
22 sessions and slid 20 percent last week, its biggest drop
since the five days through June 24.

The euro area’s second recession since 2008 has damped
industrial demand for permits, driving their price to record
lows as volatility surged. A proposal by the EU regulator to cut
supply is facing opposition from some members of the European
Parliament, increasing uncertainty. The 54 billion-euro ($73
billion) market is at risk of “total collapse,” Bas Eickhout,
a Dutch member of the Brussels-based parliament, said Jan. 22.

“There is an immediate risk that prices could fall even
further if the market’s perception that the EU cannot implement
a rescue plan for the market continues,” Paolo Coghe, a senior
European power, coal and carbon analyst at Societe Generale SA,
said Jan. 28 by phone from Paris. “When the opportunity to sell
presents itself, the market jumps on it.”

The region’s emissions trading system, or ETS, imposes
pollution caps on about 12,000 installations owned by
manufacturers and power plants. Those so-called compliance
buyers purchase the credits to conform with limits on greenhouse
gases, with each permit allowing a company to emit one metric
ton of carbon dioxide.

Slowing Output

As industrial output slowed, regulators have had little
room to curb the decline in prices because there is no mechanism
for cutting supply.

December EU permits dropped 40 percent this year and fell
to a record 2.81 euros a metric ton on Jan. 24. The contract
traded at 3.97 euros a ton at 1:04 p.m. in London. Prices moved
in a 96 cent range today, compared with a daily average of 49
cents last month and 39 cents for the front-year contract in
January 2012.

Permits tumbled as much as 36 percent to 2.81 euros a ton
in a minute on Jan. 24 after the European Parliament’s industry
committee rejected a measure aimed at allowing regulators to
adjust the permit supply. The parliament’s environment committee
will meet on Feb. 19 to discuss and vote on the proposal.

Daily trading of all carbon futures contracts on ICE on
Jan. 24 was 53 million tons, the most since Dec. 11 and almost
seven times as much as on Jan. 2. The increase isn’t reflected
in open interest, which rose 6.6 percent to 980 million tons
from Jan. 2 to Jan. 24.

Speculative Traders

“That’s a strong sign that there are more speculative
traders than compliance buyers,” Coghe said. “Compliance
buyers have a much lower tendency to trade in and out.”

The number of available permits surpassed industrial and
utility demand by about 1.6 billion at the end of last year,
Kathrin Goretzki, an analyst at UniCredit Bank AG in Munich,
said in a Jan. 29 report. That’s the most ever and equivalent to
about 80 percent of a year’s supply, according to Bloomberg New
Energy Finance data.

A majority of EU governments will probably vote in favor of
the so-called backloading plan, with some countries signaling
conditional support or urging more ambitious measures, according
to three EU officials. The proposal is still short of qualified
majority in the EU ballot system and votes by seven countries
including Germany holds the key to the decision, they said. The
other six countries are Portugal, Hungary, Malta, who are
undecided; and Cyprus, Greece and Czech Rep, which voiced
concerns. Poland opposes it.

Cutting Forecast

The commission’s plan is “marginally” more likely to pass
than fail, Trevor Sikorski, Barclays Plc’s director of European
energy markets research in London, said Jan. 23 in a research
note. Prices will average 5.5 euros in 2013, he said, cutting an
earlier forecast by 35 percent. The contract will fall to 3
euros should the proposal fail, he said. Nations may block the
proposal should Germany abstain from voting, he said yesterday.

Postponing the sales of 900 million permits from 2013-2015
to 2019-2020 is not sufficient to save the market and should be
followed by a deeper overhaul of the EU emissions trading
system, according to Eickhout. It should include a permanent
removal of at least 1.4 billion allowances and accelerate the
pace of carbon reductions in the ETS to 2.5 percent per year
from the current 1.74 percent, he said in an e-mailed statement.

Short Sellers

“Failure to deliver a permanent solution will mean the
emissions trading scheme will continue to fail in its purpose of
delivering domestic emissions reductions and stimulating
investment in green technologies,” he said.

Declines in prices since early December have worsened as
traders carried out short sales, in which they borrow permits
from companies and sell them in order to buy them back at a
cheaper price, Coghe said.

One sign of bearish speculation is rising volume in options
to buy permits at prices far above current levels, purchased by
traders to offset short positions, Coghe said. Last week, more
than 10 million options to buy at 7 euros and above changed
hands on ICE compared with 5.5 million tons a week earlier.

“Traders will be able to short the market and benefit from
volatility, while compliance players may not because they have
to hold on to their permits,” Matthew Gray, an analyst at
Jefferies Group Inc. in London, said Jan. 29 by e-mail.

Factories and power stations must surrender permits
matching their emissions from the previous calendar year no
later than April 31 every year.

For compliance buyers, the best course of action amid
spiraling speculation may be to take a view on when prices will
reach a bottom, SocGen’s Coghe said.

“You could simply decide not to buy until you think the
price won’t drop any further,” he said. “You would have to
convince risk managers to allow you to do that.”